Short selling: betting on price declines
Introduction
In financial markets, most people associate profits with rising prices. But what if we told you that you can also profit when prices fall? This is known as short selling, a strategy used by investors and traders to profit from a decline in the price of a particular financial asset, such as stocks, currencies, or cryptocurrencies.
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What is short selling?
Short selling is the process of borrowing a financial asset (such as a stock or currency) from a financial broker and selling it in the market at the current market price, intending to buy it back later at a lower price and then return it to the broker. The difference between the selling price and the buying price is the profit earned by the trader.
Simplified example:
You borrow a share of XYZ company at a price of $100.
You sell it directly in the market.
After a while, the price drops to $70.
You buy the stock from the market at its new price ($70) and return it to the broker.
Your profit = $100 (selling price) - $70 (buying price) = $30 (before fees).
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Steps for short selling
1. Open a margin account with a broker that allows short selling.
2. Borrow the financial asset (such as a stock or cryptocurrency) from the broker.
3. Sell the asset directly in the market at the current price.
4. Wait for the price to drop.
5. Buy the asset back at a lower price.
6. Return it to the broker with payment of any interest or borrowing fees.
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When is short selling used?
Short selling is typically used in the following cases:
Expecting the price to drop: When an investor believes that a particular asset will see a decline soon.
Hedging: To protect an investment portfolio from declines.
Day trading or speculation: By active traders who benefit from market volatility.
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Advantages of short selling
Profit from falling markets.
A powerful hedging tool against downside risks.
Increase market efficiency by uncovering overvalued companies.
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Risks of short selling
Despite its benefits, short selling carries high risks:
1. Unlimited losses: If the asset price rises instead of falling, you have to buy it at a higher price to close the position, which can lead to significant losses.
2. Additional expenses: Such as borrowing fees and daily interest on open positions.
3. Legal and regulatory risks: In some markets, short selling may be temporarily banned during sharp fluctuations.
4. Short squeeze: Occurs when the price rises quickly and short sellers are forced to cover their positions, pushing the price even higher.
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Famous historical examples
GameStop (GME) in 2021: The stock saw a massive surge due to short selling pressure organized by individual investors against huge hedge funds.
Global recession 2008: Some traders used short selling to make massive profits from the decline of real estate and stock markets.
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Is short selling available to everyone?
No. Most platforms require specific conditions for short selling, such as:
Having a margin account.
A certain level of experience.
Compliance with regulatory controls.
In the world of cryptocurrencies, some platforms like Binance or Bybit offer tools that allow for short selling through perpetual contracts or futures.
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Conclusion
Short selling is a powerful tool for profiting from falling prices, but it carries significant risks that require a deep understanding of the market and high discipline in capital management. It is not recommended for beginners without proper training and learning, but it remains one of the important tools in the arsenal of professional traders.
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